Sub Sandwiches

The next time you stop by your local department store, there's a good chance you might see a fast food restaurant or a vitamin shop taking up some of the space. These retailers, along with big-box chains and grocery stores, are embracing the concept that Wal-Mart has made so popular — the store within a store.

Whole Foods Market, for example, now leases space at its stores across the country to local food sellers, including chocolatiers, bakeries and sushi stands, according to Lee Peterson, vice president of brand and creative services for WD Partners which is based in Dublin, Ohio.

During tough economic times, retailers often need to downsize their stores as one way of shaving expenses. By subleasing space, retailers can relieve some of the pressures from rising occupancy costs.

In fact, a survey conducted exclusively for Retail Traffic and Trade Dimensions found that 90 percent of retailers report occupancy costs have increased over the past two years. The average occupancy cost for retailers is 10 percent of sales, and retailers estimate occupancy costs have jumped an average of 7 percent. Respondents point to the rising costs of construction, utilities and insurance among the reasons for the increase, as well as higher common area maintenance (CAM) charges.

The survey found more than 50 percent of retailers say their occupancy costs exceed 10 percent of sales. One in 10 retailers reported their occupancy costs exceed 15 percent of sales.

As the economy further weakens, experts anticipate more retailers will be willing to experiment to reduce operating expenses, including subleasing.

Keeping shoppers in the store

“A full demise is a very expensive option, so it makes a lot of sense to try to find small uses that can operate within their stores,” says Ruth Coan, partner with the Shopping Center Group in Atlanta.

Although the idea of “stores within stores” is one of the oldest retailing concepts, it's one that only a handful of retailers practice today, according to Gar Herring, president of MG Herring Group, a Dallas-based developer. He notes that department stores were among the first retailers to lease out portions of their store to other companies, literally selling space in their stores to apparel brands such as Polo Ralph Lauren Corp. and Liz Claiborne who, at the time, didn't operate their own full-line stores.

These behind-the-scene deals were invisible to shoppers, but the result was apparent: The deals added new lines of merchandise and brands to familiar stores, invigorating them in the process. In best-case scenarios, bringing a subtenant in not only generates its own sales but boosts the main tenant's bottomline as well.

Out-and-out subleasing of space to other retailers takes this relationship to another level, says Spence Mehl, senior vice president of RCS Real Estate Advisors. He's working with a national department store chain that is thinking about moving the interior entrances at some of its stores back 40 feet and subleasing that space to smaller tenants. In the process, the chain will create its own collection of in-house, in-line shops, providing higher-visibility locations to retailers that would usually lease space in less attractive and more expensive parts of the mall.

While this setup provides more than a few benefits to both the chain and the retailers who sublease, property owners end up losing tenants and revenue. At the same time, however, owners would much rather have retailers sublease excess space rather than vacate a space entirely.

A number of retailers plan for some of their space to be subleased. Others find themselves thrust into that position. The need to sublease space can emerge from difficult market conditions. Sherif Mityas, a partner at global consulting firm A.T. Kearney, says a number of retailers are evaluating their store networks in the U.S. and are coming to the conclusion that they just have too much space. For example, Gap Inc. has recently talked of slimming down its stores.

When it comes to sharing space, however, retailers have lots of restrictions. Not only do they need to worry about that retailer from a competitive standpoint, they also might be limited by standard language in leases that prevents subleasing to retailers who compete with the center's primary small-shop tenants.

Overall, most retailers work hard to make sure that they sublease to retailers that are complementary rather than competitive — retailers who will improve the overall shopping experience rather than siphon sales from them. As an example, Robin Walker-Gibbons, executive vice president of leasing for Developers Diversified Realty Corp., points to Starbucks enhancing the ambiance of Barnes & Noble. Generally, retailers get a fixed rent from their sublease tenants.

“Yes, retailers are making money off these subleases, but most importantly, these retailers are benefiting in other ways,” Walker-Gibbons says.

Competition is not only a concern for retailers, but also for developers and owners. It's fair to say most developers and owners could do without the whole store within a store concept. When retailers sublease space to other retailers, it limits the type of small retailer who can occupy space within the rest of the center.

“It's possible that a retailer is going to cut a deal that might be a little more attractive than ours, and a smaller retailer might choose to sublease space rather than come into our small-shop space,” Walker-Gibbons notes. “That's a negative. But there's always the chance that retailer might generate more sales because of its sublease tenant so we might get more in percentage rent.” However, landlords typically have little recourse if conflicts emerge because of subleased space. Some restrictions are part of standard leases. But beyond that language, landlords have no protection.

In addition to department stores, Wal-Mart is widely known for its sublease program. Across the country, the discount giant leases space to a variety of retailers from service-oriented retail, including banks and hair salons, to quick-serve restaurants such as McDonald's and Subway. The typical Wal-Mart has between 10,000 square feet to 20,000 square feet of space for sublease.

Over the years, Wal-Mart's rationale for subleasing has changed, says Walker-Gibbons. Previously, the retailer only leased space to food operators. Today, the company is subleasing space because it's a revenue generator.

Wal-Mart and many other retailers approach subleasing proactively — they plan for and lease extra space so they can bring in other retailers. Barnes & Noble, for example, always leaves room for Starbucks at its stores in order to create a one-stop shopping environment to draw more customers and to increase the frequency of trips.

And, by including other offerings, retailers such as Wal-Mart and Target are doing everything they can to keep people in the stores just a little longer and hopefully, by being in the stores longer, shoppers will spend just a bit more money.